A healthier outcome for Azure

Azure Healthcare (AZV) announced this week that it had failed to reach an agreement with the party who recently proposed a conditional takeover offer. Again, no details were announced of who the company is or the price of the conditional offer.

While the share price has since sold off, the announcement may actually be good news for shareholders.

The reason for this is that if the bid was a low-ball offer, i.e. less than 40 cents, then we believe Azure is best to continue on its current path. That way, the company will maximise potential shareholder value through positioning in a rapidly growing market.

In our view a successful offer would require a large premium to the recent share price range, given the company’s very strong near-term outlook.

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In regards to branding strength, Azure has been described as “the Coca-Cola of nurse call systems” and CEO Robert Grey has spent the best part of 30 years harnessing relationships with a customer list of hospitals and other health care providers that now exceeds 8,000.

Given this dynamic, we think it’s unlikely that the recent proposal is the last the company will see. With Grey owning 29%, and the combined board owning approximately 42%, there is strong alignment between the board and shareholder interests.

Grey is 59-years-old and has already retired once after selling Austco Communications to TSV in 2007. He founded Austco in 1986 and came back to pick up the pieces after TSV Holdings hit troubled times through the GFC.

If it was a local competitor bidding, then there are two potential issues that could have arisen. For one, it would be difficult for an Australian-based company to justify a large premium if it didn’t fully appreciate/value the large opportunity in the US. Another issue could have been getting access to company IP during the due diligence process. Without certainty of an offer, and especially without a large premium, it is unlikely that full access would have been given to a direct competitor.

A US-based company would be able to justify the largest premium, given the company’s strong positioning to roll out its clinical workflow solutions in the region. Further evidence of this position was displayed by the company announcing $US5 million in recent orders across North America. Given the forecast gross margin of 55-60%, the new orders will have a material impact on the bottom-line result.

AZV has more than enough on its plate trying to keep up with customer demand, and hence for now will be happy to shift focus back towards its growth strategy.

The manufacturing facility in the US is currently operating on a single shift, and hence has the capacity to increase production. With sales momentum rapidly gaining traction, this additional capacity may be required in the next 1-2 years.

With gross margins of 55-60%, and a higher proportion of software sales to flow through future earnings before interest, tax, depreciation and amortisation, and net profit after tax, margins are set to rapidly increase. If 20% annual revenue growth proves to be sustainable, then the earnings per share growth will justify a much higher share price in 1-2 years.

The company’s conservative accounting policy expenses many costs that could be capitalised on the balance sheet. For example the FY14 NPAT result will include some one-off costs such as the development of the US-based site.

This week’s announcement doesn’t change our positive view on the company. It may reduce the short-term likelihood of a takeover; however it doesn’t remove the possibility all together. As we mentioned last week, buying just for takeover is generally not a good strategy. Our outperform recommendation is based on forecast earnings growth, and the growing clinical workflow based earnings growth in the US.

There is no change to our recommendation, with a 39 cent valuation. The full-year results, or a pre-June 30 profit upgrade, are the next likely share price catalysts.